10 Commercial Real Estate Terms You Should Know

When you are starting out as a real estate investor, there are 10 commercial real estate terms that everyone should know. If you are just getting your feet wet, the world of real estate can be intriguing, but it can also be intimidating. You know the basics like broker and tenant, but how does each apply to the process of a commercial real estate transaction?

We have gathered the Top 10 commercial real estate terms you should know that will assist you in being effective at your job and making each transaction as lucrative as possible.

1) Building Classes – A, B, C

Class A Building

This type of building is on the top tier of building quality. They are in prime locations, have state-of-the-art amenities, and offer the best upkeep of the three classifications. They also hold the highest price tag and the lowest return on investment.

Class B Building

These buildings are in the middle of the road. Not the best, but not bottom rung either. They are often older but still in good locations and offer investors the opportunity to increase the value of the building with renovations.

Class C Building

Class C buildings are usually in poorer locations and either older or need repairs. These are typically small businesses or lower-end apartment complexes.

2) Usable Square Footage

This is the square footage your tenant will use within the building. Compared to the actual rentable area, it is lesser because it will include common areas shared with other tenants.

3) Rentable square Footage

This is the square footage that will include both usable square footage as well as shareable space with other tenants of the building. This will include restrooms, lobbies, and even cafeterias. There can even be a Common Area Maintenance (CAM) Fee for building residents.

4) Letter of Intent (LOI)

A non-binding written agreement that spells out the terms of a purchase between two or more parties.

5) Tenant Representation

This type of rental agreement has a mediator representing the landlord. This mediator is often the broker or a real estate agent. They assist in negotiating issues that would arise between the landlord and the tenant.

6) Landlord Representation – Leasing agreement

Like a tenant representation, only the mediator represents the best interests of the location’s owner versus the tenant.

7) Purchase Sales Agreement PSA

The document that spells out the acceptance of the final offer. It is drawn up by the buyer’s representative. It will include the following:

• Final agreed sale price
• Earnest money details
• Due diligence timeline
• Contingencies; appraisal or inspection
• Closing date
• Title information
• Additional legal information

Once agreed upon, both parties will sign it, and it will go into effect. Remember, while this does complete the sale process of the home, it can be contested during the home sale process with inspections and other contingencies.

8) Net Operating Income (NOI)

This figure is found by taking all the rental revenue income from the property minus all the operating expenses. However, it is before deducting taxes and financing expenses. This number will help determine the overall value of the investment. If the NOI increases, the property value does likewise. Such can be said of a decrease.

9) Capitalization (CAP) rate

This is the expected return on investment (RoI) of a property investment. A low CAP rate is beneficial to the investor. These usually carry a higher sales price because they are lower risk. Those with a higher CAP rate, and higher risk, will carry a lower sales price.

The CAP rate is calculated by dividing the NOI (Net Operating Income) by the property’s market value. Appraisers use this to help determine an actual value of a commercial property.

10) Return on Investment (ROI)

We just spoke of the CAP as the expected; the RoI is the actual return ratio of net income on funds invested. A high RoI will mean a favorable return for the investor. With an RoI, the amount returned is not the only factor. Time is also a primary factor in determining the worthwhileness of an investment. The longer it takes to make back the investment funds, the lower the RoI will become. The quicker the turnover of the sale, the higher the return will be.

Final Thoughts

While these are just a handful of terms within the realm of commercial real estate, they are ten of the important definitions you will need to get started. Education helps you make informed decisions and gives you the edge you need to help clients make the larger investments and feel confident you have their best interests in mind.